What to do about BlackBerry?

First off it was a pleasure me meet with many of you at the Toronto Options Education Day this past Saturday. I spoke on the topic of Options as a Portfolio Management Tool. The video will be available in March on the www.m-x.tv Montreal Exchange educational site. After speaking, I was approached by a number of attendees all asking me what I thought about Research in Motion (TSX:BB) as an opportunity. I politely reserved no opinion on the future of the company, but rather emphasized the options strategies that would be appropriate.

No sooner than the next trading day, Canaccord Genuity revised down their estimates of BlackBerry Z10 by 1.5 million units for this quarter. To read the story, visit:
http://business.financialpost.com/2013/02/19/canaccord-cuts-blackberry-10-shipment-estimates-by-1-5-million-for-february/. Talk about a mixed picture. On the one hand you have the Research in Motion team put together an absolutely top of the line product, but the tepid consumer response is making carriers reluctant to stockpile the smart phones.

Under all the circumstances, I am going to remain impartial as there are reasons that the company could be successful, but also equally the chances that they disappoint. I would rather like to focus on answering the simple question:

If an investor did want to participate on the upside of Research in Motion, how can one effectively manage the risk?

There is no denying the extreme volatility that this stock has experienced. Just in the 6+ weeks of 2013, the stock swung from $11.00 to $18.00, back to $12.00, back up to $17.00, down to $13.00 before closing on Tuesday February 19 at $14.57. Any day traders or swing traders looking to profit have a substantial risk in using stop losses. Realistically how can a trader place a reasonable stop loss that is outside the normal band of volatility?

Now an investor could consider just buying a call option, but with an implied volatility of over 80%, the premiums are very rich. As an example, the June $15.00 call option is asking a rich $2.54.

Here are the facts on the June $15 call option:

• If held to expiration, the call gives the buyer the right to buy the shares at $15.00.
• Having paid a premium of $2.54, the break even would be $17.54. The stock would have to be trading over $20.00 a share to have to potential for a 1:1 risk/reward payoff.
• If the stock closes below $15.00 the entire $2.54 is a loss.

Overall, I find that to be a bad proposition and unattractive unless you have the most bullish of outlooks.

So what alternatives can a trader consider?

A call credit spread would present a far more attractive proposition if the trader had more modest expectations. If you are unfamiliar with the bull call spread strategy, watch this short 10 minute educational video: http://www.m-x.tv/media/bullish-spread-strategies

In this example, the trader is considering the $15.00/$20.00 June bull call spread.

• Purchase the $15.00 strike call option for $2.54.
• Sell the $20.00 strike call option for $1.05. This short call is collateralized by the long call.
• This reduces the net cost to $1.49 for a spread.
• If BB rallies above $20.00 by expiration, the spread would be worth up to $5.00 or $3.51 profit.

Why might this be a better choice?

1. It reduced the total capital at risk by 40%.
2. It hedges short term time decay and changes in volatility.
3. It reduces the break even on the position to $16.49.

The risk reward proposition of $1.49 risk to a $3.51 profit potential is quite reasonable.

The key benefit, in my eyes, is that if the BlackBerry story fades and the stock price fades with it, shareholders have considerable downside risk back to the lows of 2012. The options trader with the spread can define the loss and still have plenty of room to participate if the stock was to move higher.